1.Ownership implies control.

2.Common stockholders often have the right, called the preemptive right, to purchase any additional shares sold by the firm.

B:The value of any stock is the present value of its expected dividend stream: ￼ ￼

However, some stocks have dividend growth patterns which allow them to be valued using short-cut formulas.

B2:A constant growth stock is one whose dividends are expected to grow at a constant rate forever. Many companies have dividends which are expected to grow steadily into the foreseeable future, and such companies are valued as constant growth stocks.

For a constant growth stock:

D1 = D0(1 + g), D2 = D1(1 + g) = D0(1 + g)2, and so on.

With this regular dividend pattern, the general stock valuation model can be simplified to the following very important equation:

￼ = ￼ = ￼.

B3:The model is derived mathematically, and the derivation requires that rs > g. If g is greater than rs, the model gives a negative stock price. The model simply cannot be used unless (1) rs > g, (2) g is expected to be constant, and (3) g can reasonably be expected to continue indefinitely. Stocks may have periods of supernormal growth, where gs > rs; however, this growth rate cannot be sustained indefinitely. In the long-run, g < rs. C:The SML is used to calculate temp force’s required rate of return:

rs= rRF + (rM – rRF)bTemp Force = 7% + (12% - 7%)(1.2)

= 7% + (5%)(1.2) = 7% + 6% = 13%.

D1:Temp Force is a constant growth stock, and its dividend is expected to grow at a constant rate of 6 percent per year. Expressed as a time line, we have the following setup. Just enter 2 in your calculator; then keep multiplying by 1 + g = 1.06 to get D1, D2, and D3:

0 1 2 3 4 | | | | |

g=6%

D0 = 2.00 2.12 2.247 2.382

1.88 (Year 1)

1.76 (Year 2)

1.65 (Year 3)

D2:Since the stock is growing at a constant rate, its value can be estimated using the constant growth model:

￼ = ￼ = ￼ = ￼ = $30.29.

D3:

￼ = ￼ = ￼ = ￼ = $32.10.

D4:The expected dividend yield in any year n is

Dividend Yield = ￼,

While the expected capital gains yield is

Capital Gains Yield = ￼ = r - ￼.

Total return = 13.0% Dividend yield = $2.12/$30.29 = 7.0%

Capital gains yield = 6.0%

E:Constant growth model - Rearranged

￼s= ￼.

Expected Return:

￼s= $2.12/$30.29 + 0.060 = 0.070 + 0.060 = 13%.

F:

0 1 2 3 | | | |

2.00 2.00 2.00

1.77 (Year 1)

1.57 (Year 2)

1.39 (Year 3)

.

.

.

P0 = 15.38

P0 = PMT/r = $2.00/0.13 = $15.38.

G:Temp Force is no longer a constant growth stock, so the constant growth model is not applicable. The easiest way to value such non-constant growth stocks is to set the situation up on a time line as shown below:

0 1 2 3 4 | | | | |

2.600 3.380 4.394 4.658

2.301 (Year 1)

2.647 (Year 2)

3.045 (Year 3)

46.116 (Year 4)

54.109

P0 = $54.109.

The dividend yield in year 1 is 4.80 percent, and the capital gains yield is 8.2 percent:

Dividend yield = ￼ = 0.0480 = 4.8%.

Capital gains yield = 13.00% - 4.8% = 8.2%.

After year 3, the stock becomes a constant growth stock, with g...

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